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Never reason from a price change – version #436552

This is ECB’s chief economist Peter Praet in an interview with Les Echos:

“Normally, a fall in prices would be able to support purchasing power and, therefore, domestic demand. But demand has remained weak, including in the biggest euro area economies”

It seems like Praet is not entirely sure about the difference between supply and demand shocks, but let me just illustrate the dffference in two graphs (I don’t have much time so I did it by hand and with the help of an iPhone…)

3 Comments

It’s striking how obvious this idea seems once you hear it, yet how hard it is to convey to those unfamiliar with it.

I’ve found that even people with economics PhDs and years of model building and forecast experience will just stare blankly when I say that asset prices aren’t a great variable to drive a stress testing model. Reasoning from price changes is such an ingrained part of private sector forecasting/modeling that this argument is often a hopeless effort.

The amazing ignorance of the ECB intelligentsia.
“Unless some counteracting cause comes along to prevent the fall in the price level, a depression tends to continue, going deeper, in a vicious spiral, for many years. There is no tendency of the boat to stop tipping until it has capsized. Only after almost universal bankruptcy will the indebtedness cease to grow. This is the so-called “natural” way out of a depression, via needless and cruel bankruptcy, unemployment, and starvation. On the other hand, it is always possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged. If our rulers should still insist on leaving recovery to nature and should still refuse to inflate in any way, should vainly try to balance the budget and discharge more government employees, to raise taxes, to float, or try to float, more loans, they will soon have ceased to be our rulers. For we would have insolvency of our national government itself, and probably some form of political revolution.
—Irving Fisher, “The Debt-Deflation Theory of Great Depressions”, 1933.